IT Budgets and ROI

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After several years of doom and gloom, IT budgets will, depending on whom you talk to, (a) increase slightly, (b) increase very slightly, or (c) stay flat. Even the most optimistic predictions give little cause for celebration because, as Gartner research director Barbara Gomolski notes, “Most companies cut their budgets over the past few years, and [even with an increase in 2004], we won’t have made up for that.”

AMR Research has found that in this year’s third quarter, executives were more optimistic than they’ve been in three years. “People expect to expand their business next year. They see some positive [economic] signs out there,” says AMR research director David O’Brien. But caution, he says, remains the watchword. “Despite some positive signs, companies are not hiring people and not making the dramatic investments they would have if they had seen those signs two or three years ago. We’ve learned some hard lessons about what happens when you invest in the business ahead of revenues and profitability.”

And even if IT budgets increase in the aggregate, loosened purse strings will vary by industry and will likely be driven by a few items on companies’ shopping lists. Gartner says petroleum, retail, health care, and financial-services sectors will spend more, but that manufacturing, transportation, and electronics, among others, will continue to cut. Surveys conducted by AMR find that databases, physical, infrastructure, and security are the areas most often cited as due for spending increases.

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“Discretionary IT spending may never come back for some industries,” says Val Sribar, senior vice president and principal analyst at Meta Group, adding, “Unlike in the old days, a significant portion of the budget now gets revisited each quarter. The starting budget can end up looking dramatically different come March.”

Indeed, even though AMR’s survey results were among the more optimistic of the looks ahead to 2004, O’Brien says “the theme for next year is ‘cut costs, cut costs, cut costs.'” So much for good things coming in threes.

Tinkering with the Equation

Whether a company cuts, maintains, or increases IT spending, virtually all organizations will attempt to bring ever-more rigor to spending decisions. That has often been perceived as a CFO’s primary contribution to IT strategy. But these days, pressure for demonstrable returns is just as likely to come from even higher up on the food chain.

“If you are on the board of directors of a company, you are fairly jaded by technology right now,” says Sribar. “What have you heard in the past 10 years? All that talk about Y2K? Or that dot-coms would change the world? Good board members are asking, ‘Why do I want to spend money on technology?’ They’re skeptical; they are questioning more and forcing people to justify what they are doing.” That means the quest for appropriate measures of ROI will intensify.

Some traditional ROI metrics for IT projects just don’t cut it anymore, according to Gartner’s Jeremy Grigg. There’s more pressure to provide robust business cases up front, he says, ones that look past implementation costs to a project’s effect on long-term business plans. Vendor calculators are out, he says, as customers up the ante by asking for “more scenarios, sensitivity analysis, and a better understanding of project interrelationships.”

As one of many examples, a company called Renovance touts its ActiveROI model as a way to view IT investments holistically, managing them based on three disciplines: architecture, service management, and IT asset management. The company says IT should be managed via key metrics that describe how it enables the business to engage the market.

Consulting firms that built their reputations telling customers what to buy have quickly shifted their focus toward how to buy. From Gartner’s Total Value of Opportunity to benchmarking tools such as The Hackett Group’s Business Value Index, many offerings take traditional ROI concepts such as internal rate of return and net present value, bundle them with proprietary metrics and scorecards, and sell them back as (often patented) methodologies of dizzying complexity.

So much so, in fact, that some analysts forecast a back-to-basics movement as the biggest trend in IT ROI. “CIOs need to start thinking like CFOs when they do financial analysis,” says Ian Campbell, CEO of Wellesley, Massachusetts-based Nucleus Research Inc. “They have to use the basic fundamentals of ROI that go back to Henry Ford. If you ask a CFO to calculate the ROI on an oil tanker, it will take him weeks. If you ask a CIO to calculate the ROI on the Palm Pilot they give the captain of that tanker, it will take months. There’s a basic immaturity there when it comes to understanding finance.” Campbell says that time-to-payback is the single most useful form of ROI, in large part because technology and business needs change so fast that a focus on IT projects designed to pay off in months rather than years is the wisest course of action.

One back-to-basics tool, IT portfolio management, gathered steam in 2003, and many analysts see it making more headway in 2004. The approach treats IT projects as though they were a portfolio of financial investments, with constant reevaluation regarding their value to the company. “Portfolio management will really raise the bar on the accountability of IT to finance managers,” says Gartner’s Grigg. Meta Group’s Sribar says this allows companies to pull the plug on costly projects before they spiral too far out of control.

Talk the Talk

If at its root ROI is an effort to bring more intellectual horsepower to IT decisions, another approach may be to simply enhance a company’s overall finance savvy. A knowledge of basic finance is often lacking in a typical IT department. For example, in a joint study of 130 senior IT executives by the Society for Information Management, the Kellogg School of Management, and DiamondCluster International earlier this year, 74 percent of respondents said they would like to have a strategy to regularly calculate technology ROI, but that 51 percent “have no process to align and evaluate IT investments with business strategy.” And 42 percent acknowledged that their IT staff lacks “sufficient working knowledge of financial concepts.”